One of the things options traders (and stock traders) struggle with is the mental game that comes with trading. You will be hard-pressed to find a single person who trades daily and remains unaffected by the market’s emotional displays.
The market, price action, and trading volume are a sea of emotions, all of which you can see on a chart – fear and greed are represented by the green and red bars (buying and selling). Think of the chart as a football field, with fear on one side and greed on the other. We are all trying to move up or down the field with a minimal amount of emotion, but we are often pulled to one sideline or the other for various reasons.
To be successful, we need to overcome the need to be 100% informed, because most of what the market communicates is uncertainty. Nobody can tell the future with 100% accuracy, hence the right side of the chart is a mystery. We are constantly looking for clues and listening to anyone we deem smarter than us who might make our job a bit easier. Do we listen to Carl Icahn who says a big correction is coming? We already know that a correction will happen one day. Do we sell when he says to? What about David Tepper or George Soros – do we follow their lead when they say “Don’t be too long at this time?” What do we do when a month later they say, “Oops, I didn’t really mean that?”
When trading options, studying the charts and listening to the market – not to people – will guide you to better results. News is important to understand and digest, but you have to put it in context so it’s relevant. More importantly, you need to look at how the market is reacting to the news at a certain moment in time.
Take the first week in August, for example. After getting pushed about 40 handles lower on HUGE volume August 7, there was some news that dropped futures overnight another 10-13 handles. It appeared the SPX 500 would open under 1900 for the first time since it first crossed over it in late May.
But alas, the markets were vastly oversold at that point, sentiment was as bearish as could be, the VIX was up nearly 40% in a week, and put/call ratios clocked at over one for a few days. Basically, we had conditions that could not last too long; the rubber band was stretched back way too far.
As a contrarian looking at trends, I saw that the odds favored a swift and strong turn up. Markets were falling on bad and good news and were pasted in a short 4-6 sessions. If you were long on stocks or call options, you started questioning yourself, because if this was “the end,” who wanted to be left holding the bag?
Yet, with the markets so oversold, overnight news had a negligible effect on the markets on August 8, and they rallied sharply. (Coincidentally, they rallied off the 100 ma, which had been a great spot for buying modest 3-4% pullbacks this year – see the chart below.)
My point is this: The news was important, but understanding the market conditions was much more important. Just when you might have thought this market would fall apart (everyone on CNBC seemed to think this way), you would have been badly burned if you played the downside last week.
How would this have affected your mindset? Your head probably would have exploded. I suggest that you pay attention to the message of the markets, be open-minded to conditions, and allow yourself a chance to be successful. I say it often, and I’ll say it again: Options trading is not a game of perfect. Prepare your mind for the mental game of options trading, and you can be on the winning side more frequently.
SPX 500 August 16, 2014
